By Paul Ploumis 23 Jul 2015 Last updated at 05:43:37 GMT
(Kitco News) - Despite gold’s selloff earlier in the week, CME Group’s senior economist says the metal has proved to be relatively stable when compared to other commodities over the longer term.
However, he added that this could just be “the calm before the next storm.”
“While a range of commodities, including crude oil and iron ore, have been on a wild ride over the past twelve months, gold has been comparatively stable,” said CME’s Erik Norland in a report released Tuesday.
Norland focused on implied volatility in gold, which he said, tends to rise “when prices are falling, more so than when prices are rising,” adding that there are reasons why this volatility could rise.
“Before we delve into reasons why the price of gold might fall, it is worth noting that implied volatility on gold options has risen during gold bull markets in the past. Notably this was the case in August and September 2011, just as gold reached its all-time high (nominal) price in U.S. Dollars,” he noted.
However, as prices fell, “gold implied volatility pushed even higher, peaking at 36.2% annualized on constant maturity 30-day options on gold futures,” he added.
According to Norland, the first reason it could rise is because both implied and realized volatility are “abnormally low,” especially over the long and intermediate term.
“Currently, with gold options trading near a record low in terms of implied volatility (12.1% as of July 14, 2015 and up to 18.8% on July 21, 2015), there is little scope for gold implied volatility to decline further,” he said.
“By contrast, there is a great deal of room for it to go higher,” he added.
Gold prices could also be set to decline – higher volatility – because of increased in mining supply.
“[M]ining supply explains as much as 50% of the year-to-year price variation in precious metals,” he explained, adding that although some observers expect supply to contract, he is skeptical.
“While the current price of gold…is far below its high of around $1,900 from September 2011, the current price still exceeds most estimates of the cost of production,” he said, which would not push operating mines to slash production just yet.
Other factors that could affect implied volatility include gold’s relation to oil prices as well as U.S. monetary policy and the dollar.
Looking at the much anticipated Federal Reserve rate hikes, that many believe will hurt gold prices further this year, Norland said that what matters most for the metal is not so much the actual Fed move, but rather how the “expectations of a Fed move develop over time.”
“Additionally, if Fed rate hike expectations are brought forward (meaning more rate hikes sooner than currently priced) it would also likely support the U.S. Dollar,” he added, noting that this would likely hurt gold prices.
Although diminishing expectations of a Fed move have prevented gold from falling as much as other commodities, the higher potential of monetary policy tightening this year, as well as an increasing mining supply, gold prices could be headed lower.
“After all, gold is typically bought as a hedge against inflation – of which there is none – or as protection against financial disasters – central banks have the markets’ back for now. While history is not always a good guide, caution is advised since we may be experiencing the calm before the next storm.”
Courtesy: Kitco News
